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July 25, 2013

Morningstar Guru Johnson: The Cons and Pros of Active ETFs

Ben Johnson explains his skepticism, gives his insight and offers hope for the active ETF space

With the ongoing (and seemingly never-ending) active versus passive management debate, how it plays out in a mutual fund versus an ETF format and all the attendant arguments, where can one go for the “straight dope” before making a decision?

Ben Johnson, director of passive funds research with the Chicago-based firm, offered three points to consider before taking the active route. But don’t let his title throw you; he likes the active ETF concept, but advises investors approach with a heavy dose of skepticism.

“2011 was supposed to be the ‘Year of the active ETF,’” Johnson (left) told ThinkAdvisor on Thursday. “The clock was supposed to strike midnight on Dec. 31, 2010, and we would be off and running. That didn’t happen.”

When 2012 rolled around it was about “an” active ETF, rather than active ETFs in general.

“It was one company based in Newport Beach, Calif., that introduced what was essentially the younger brother of the single largest mutual fund strategy in the world,” he said, referring to PIMCO’s Total Return ETF (BOND) without specifically naming it.

Johnson considers its success a “mathematical inevitability.”

“You have Bill Gross behind it, who was Morningstar’s Fixed Income Manager of the Decade for the aughts. But it’s not just performance, it’s also the fees. I‘d argue that it’s really just a different distribution method. You go from A-shares in a mutual fund with front-end loads and expense ratios and put it in an ETF pipe instead, which results in substantial cost savings for the end investor.”

A pro for managers considering launching an ETF strategy of a mutual fund can either be a small fish in a very large pond (mutual fund) or a medium-sized fish in a much smaller pond, Johnson added. “From a business and marketing sense, that has appeal,” he said.

But other issues are decidedly in the con column, specifically daily transparency.

“If I’m running a concentrated equity strategy, why would I want to sit down at the table and immediately show my hand?” he rhetorically asked, before noting that in the fixed income space, the chances of front-running impeding success are “infinitesimally smaller than, say, if I’m running a concentrated value strategy.”

All that said, Johnson concluded by saying he hopes active ETFs gain in popularity.

“Ultimately, at the end of the day, the reduced costs and fees mean more money in the end-user's pocket, and that’s a good thing.”

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Listen in on Johnson’s (at times heated) discussion with Gary Gastineau, principal of ETF Consultants, and AdvisorShares’ CEO Noah Hamman about the role of active ETFs by registering for the replay of our virtual ETF summit.

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